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The clinical testing process for new drugs can be a lengthy and time-consuming process. To stay focused on their core business of developing and selling drugs, many major drug companies farm out the interim testing process to third parties, which are known as contract research organizations (CROs). For a while, CROs were all the rage as it looked as if they could garner all the work they could handle.

Growth for CROs has cooled in the last few years, however, and that has sent many share prices in the sector falling back to earth. But

Pharmaceutical Product and Development


has managed to keep growing at a rapid clip these last few years, further cementing the company's dominant position in the CRO industry.

Nonetheless, a few internal stumbles have finally brought PPDI back to earth. In just the last 10 weeks, shares have slumped from $35 to $25. Its stock price is now as cheap as the other CROs, even though the company's earnings continue to grow at a relatively faster clip.

The share price weakness is the result of an uptick in customer cancellations. Any time PPDI performs a clinical testing trial on a new drug, it runs the risk that the data won't prove to be strong enough to merit further testing. As a result, clients routinely opt to stop a trial with little notice -- it's just part of the business for a CRO.

In fact, if you go back a dozen quarters you'll find several instances in which PPD reported a temporary uptick in cancellations. In each case, the cancellation rate had trended back down to normal within two quarters. Investec PMG's Mike Martorelli points out, "Traders extrapolating a trend from a single data point have given investors good opportunities to purchase this stock at temporarily depressed prices several times during the past few years."

Plenty Of Backup

Investors are clearly focused on the wrong metric. Instead, they should be focused on PPDI's backlog of new business, which continues to swell. The backlog of new tests to conduct rose from $293 million in 1998 to $354 million in 1999 to $498 million in 2000 to $674 million at the end of 2001.

In the first quarter of 2002, PPD garnered $210 million in new orders (though that uptick in cancellations means that the net figure is well lower). Management releases backlog figures only on the June and December quarters, but the number likely will be stable if not higher when the next set of numbers are released in late July.

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A few other issues have cropped up to pressure the stock. For starters, a relatively minor deal with


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to develop oncology drugs was terminated. To put this development in perspective, though, PPDI's entire drug discovery division accounts for less than 10% of the company's total sales.

The other investor concern: CFO Phillippe Maitre resigned in mid-May, which is never a good thing. But his successor, Linda Baddour, has been the company's chief accounting officer since 1997 and is familiar with the books.

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And while CFOs often play a key strategic role, PPD has been predominantly led by founder and CEO Fred Eshelman. He is widely considered to be the shrewdest operator in the CRO sector, which helps explain why PPD has taken market share in four of the last five years.

Eshelman recently bought 100,000 shares after they had fallen below $24. Three other officers also bought some $250,000 in stock in recent weeks.

So once investors get past the noise associated with the March quarter, shares should regain their footing. Cancellation rates may be high again in June, but that shouldn't portend a larger operational problem. As noted above, cancellations are very much a part of this business, and these unfortunate events already appeared priced into the company's stock.

Looking past that near-term issue, PPD is poised to continue growing at a healthy clip. Per share earnings have grown 70% annually over the last five years, and are expected to grow another 32% this year to $1.24. Management is comfortable with that estimate even after accounting for an uptick in cancellations. The continued profit growth is all the more impressive when you consider that other CROs are experiencing a profit slump right now.

Because of the recent selloff, investors can now pick up shares of PPD for less than 20 times forward earnings. The stock has rarely been this inexpensive over the last five years, so you shouldn't wait too long before digging in on this one. PPD has typically risen nicely after any down periods.

Judging by the causes of the recent downdraft, the current period should be no exception.

Jonathan Moreland is director of research and publisher of the weekly publication InsiderInsights and founder of the Web site At the time of publication, Moreland had no position in any of the securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While he cannot provide investment advice or recommendations, Moreland invites you to send comments on his column to

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